European Central Bank introduces forward guidance. What is forward guidance?

Author: Eamonn Sheridan | Category: News
  • Forward guidance was pioneered by the Reserve Bank of New Zealand 16 years ago
  • It can take many forms
  • But in essence all of them involve saying, or at least hinting at, what you’re going to do before you do it

“Until recently, guidance usually involved central banks using a mix of their economic projections and their inflation targeting frameworks to show markets whether their expectations of the direction and timing of policy changes were right or not. It was all a bit techy and abstruse.No longer. Most of the focus recently has been on forms of forward guidance that the public — as well as markets — can easily understand… more explicit forms of forward guidance involve central banks promising to keep monetary policy ultra-loose either until a fixed point in the future, or until economic conditions pick up.”

Which central banks have used forward guidance?

  • The Bank of Japan said in 1999 that rates would stay at zero until “deflationary concerns” were “dispelled.”
  • The Federal Reserve in 2003  used a weak form of commitment to keep policy accommodative”
  • In April 2009, the Bank of Canada took guidance a step further by pledging to keep rates close to zero until the middle of the following year.
  • The Federal Reserve last December ruled out any rise in rates while unemployment remained above 6.5 per cent (subject to inflation conditions)

What about today’s forward guidance from the ECB?

“The ECB’s form of forward guidance is somewhere in between what the BoJ introduced at the end of the 1990s and what the Fed did in December.Like the Fed, it ties any hike in rates to economic (and financial) conditions. In the ECB’s case, these are the “subdued outlook” for inflation over the medium-term; “broad-based weakness” in the real economy; and “subdued monetary dynamics”. But, unlike the Fed, there is no explicit figure. The syntax of the statement also implies that the ECB continues to attach more importance to inflation than unemployment and growth.”

Did the Bank of England also introduce forward guidance today?

Some will argue no, not explicitly. What they did say though is that they think markets have got the timing of rate hikes in the UK wrong. That gives markets a little more certainty than the ECB about when rates in the UK will rise; but the BoE hinted they would give better guidance in August.

The full article is at the Financial Times. It is gated, but a free registration will grant access, its well worth a read: Forward guidance: your one-stop shop